Treaty Benefits for Investment Vehicles in a Post-BEPS World...You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax

Treaty Benefits for Investment Vehicles in a Post-BEPS World

University of Chicago Federal Tax Conference

November 11, 2016

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Panel

Moderator

Paul Carman

Partner, Chapman & Cutler LLP

Lead Presenter

Michael Plowgian

Principal, KPMG LLP

Panelists

Mary Bennett

Partner, Baker & McKenzie LLP

Quyen Huynh

Associate International Tax

Counsel, U.S. Department of the

Treasury



U.S. RIC Investing Outbound

U.S. Intermediaries

(e.g. private bank,

investment

manager, etc.)

U.S.

Custodian

US RIC

Swiss

Corp

Japan

Corp

U.S.

Investors

Paying

Agent

DTC /

CSD

Global

CustodianForeign

CSD

Foreign

Intermediaries

(e.g. private bank,

investment

manager, etc.)

Foreign

Investors

Notes:

Switzerland essentially treating US RIC as flow-through, and requiring

documentation of all investors. Question of residence and beneficial

ownership of income.

LOB issues with Japan and pension funds.

If US RIC is not regularly traded, how does it demonstrate that it meets

ownership/base erosion or another test under LOB?

Beneficial

ownership

of shares of

US RIC



Non-CIV Treaty PlatformNotes

• LuxCos do not have their own employees,

but rely on Third-Party Service Providers.

• The Lux entities have a Board of Directors,

with the majority residing in Lux (may be

affiliated or third party). Registered offices

and books and records are maintained in

Lux.

• Investors are a mix of US taxables, U.S.

state pension plans, perhaps U.S. private

tax exempts, then a mix of non-U.S. (U.K.

pensions, Singapore corporates, Saudi

corporate).

Questions

• What additional substance (if any) in Lux

may be needed to sustain treaty benefits

under PPT?

• To what extent is the investor profile

relevant to treaty benefits under PPT? How

could treaty benefits be sustained under

simplified LOB?

SpainCo FranceCo ItalyCo

LuxCo2

LuxCo1

CayCo

Investors



Challenges for Investment VehiclesIssues with Treaty Benefits for Investment Vehicles:

- Financial intermediation – often, multiple tiers of financial

intermediaries

- Multiple jurisdictions involved

— Different treatment of the entities

— Different interpretations of treaty eligibility

- Distinguishing between investment vehicles and other holding

companies or business entities

Result is Uncertainty

- Uncertainty regarding potential large liability distorts pricing for

investors

- May limit cross-border investment



OECD Work on CIVs

Tries to Reduce Uncertainty with Respect to CIVs- CIVs defined as investment funds that are widely held, subject to

investor protection regulation, and invested in a diversified portfolio of securities

- Concludes that in most cases, CIVs should be treated as residents and as the beneficial owner of income for treaty purposes

- Discusses government concerns about treaty shopping and deferral

— Suggests that certain CIVs (like U.S. RICs) that are subject to tax on undistributed income and that withhold on distributions to nonresidents generally should not raise concerns about treaty shopping or deferral

Limitations- Does not address non-CIVs: real estate, private equity, hedge,

infrastructure

- Recommendations not widely adopted

- Undermined by BEPS Action 6?



TRACE Project

Attempts to Address Financial Intermediation

- Inspired by QI regime

- Key elements

— Approval of intermediary by source country

— Investor self-certification

— Treaty claims made on pooled basis

— Payee-specific reporting to source country

— Independent review of compliance

No Country Has Yet Adopted, But FATCA and CRS May Facilitate Adoption of TRACE

- Financial institutions (including investment entities) collect self-certifications from, and report on, investors and account holders

- Linking with treaty benefits may improve compliance by account holders



Impact of BEPS Action 6

LOB and/or PPT to Be Incorporated in Multilateral Instrument

LOB

- Many investment vehicles (and even CIVs) are not regularly traded

- Ownership/base erosion (must identify owners)

- Derivative benefits (more than 7 owners?)

- Not active trade or business

- Pension funds

- Potential special category for CIVs?

PPT

- Inherently subjective

- Investment vehicles formed for non-tax purposes, but tax often is important in determining location

- Narrow example of “good” CIV – widely held, but more than 50% owned by same-country residents, less than 15% invested in State S securities, annually distributes almost all income



Potential Framework

Policy Concerns

- “Neutrality” for investment vehicles

- Avoid double taxation

- Prevent treaty shopping

- Avoid double non-taxation/deferral

Approaches

- Fiscally transparent entities

— Most theoretically pure; new Article 1(2) of OECD Model

— But lenders and investors often insist on entities that are not fiscally transparent

— Practical issues with accounting and reporting for funds that are widely held or if investors from multiple jurisdictions

- Fiscally opaque entities

— Need to identify owners (TRACE principles, leveraging FATCA/CRS?)

— Need to address third country owners (equivalent beneficiaries)

— Need to address deferral



U.S. Treaty Policy

CIVs- Need to agree with treaty partners on mechanism to grant treaty

benefits to RICs and treaty partner CIVs

— Technical Explanation addresses RIC residence, but generally not binding on treaty partners

— Extent of “proof” of ownership needed?

— Potential to implement TRACE principles to establish ownership?

— Equivalent beneficiaries?

Non-CIVs- Fiscally opaque – difficulties qualifying under U.S. Model LOB

— Need for expanded derivative benefits provision

- Article 1(6) of the U.S. Model

— Need for other countries to allow investors to treat entities as fiscally transparent?

— Foreign partnerships able to act as non-withholding QIs?



Non-CIV Investing Inbound

Consider impact of Irish treaty negotiations…

Manager

Fee

Originates loans in U.S.

IMA ICAV

U.S.

Investors

Saudi

Investors51%

49%

Notes:

Assume Manager does not create

dependent agent PE.

What if investors were a mix of

more than 7 other treaty investors?



Infrastructure ConsortiumFacts:

Pension 1, Pension 2 through its holding company B Co., and

a fund-of-funds (FoF) form Pooling Co. in Country B.

Countries B, C, and D have treaties with the U.S. that are

identical to the 2016 U.S. Model.

Pooling Co. is not treated as fiscally transparent under the

laws of Country C or Country D.

Parent Co. is treated as a corporation for all relevant tax

purposes and pays interest and dividends to Pooling Co.

which are subject to 30% withholding absent a treaty claim.

Observations/Questions:

Why shouldn’t Pooling Co. or its investors be entitled to treaty

benefits?

If Pooling Co. were treated as fiscally transparent for Country

C and D purposes, could it enter into an QI agreement with

the IRS? See Treas. Reg. §§ 1.1441-1T(e)(5)(ii), 1.1441-

6(b)(2)(ii)

If Pension 1 and Pension 2 can be documented, and if FoF

investors can be documented, might Pooling Co. qualify for

derivative benefits?

Project Co.

Parent Co.Bank debt

U.S.

Pooling Co.

B Co.FoF

Country B

Project

45%

45%

10%

Country CPension 1

Country DPension 2

Thank you!

Documents

Treaty Benefits for Investment Vehicles in a Post-BEPS World...You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax